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Chapter

3 Transaction Costs in the Palestinian Economy: A Microeconomic Perspective

Author(s):
International Monetary Fund
Published Date:
August 2001
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Author(s)
Felix Fischer, Mona Said and Rosa A. Valdivieso 

A longstanding concern of Palestinian business people is the high level of transaction costs involved in conducting trade in the West Bank and Gaza, which for the most part are the product of a rather unique system of complex regulations and procedures mainly linked to Israeli security considerations. Reducing such costs is important to increase the overall competitiveness of the Palestinian economy and ensure its ability to develop, prosper, and integrate with the world economy.

The experience of economies that have succeeded in achieving rapid economic growth has been that reforms of the incentives and institutional frameworks aimed at reducing the costs and unpredictability of doing business play a crucial role in private investors’ decisions. Economies where the emphasis has been on the provision of tax and other incentives to encourage investment in export-oriented manufacturing industries without the sustained pursuit of sound macroeconomic policies, trade liberalization efforts, and reform of the institutional framework have seen disappointing results.

This chapter focuses on transaction costs created by the regulations and procedures that governed trade into and out of the West Bank and Gaza prior to the recent turmoil and closures. The impact of the present turmoil and closures on the economy is covered in Chapter 1.

A brief discussion of the concept of transaction costs, their role in influencing the business environment in general, and the specific nature of such costs in the Palestinian economy is followed by a description of the day-to-day trade procedures faced by Palestinian exporters and importers, which provides a sense of their cost implications. The chapter later looks at possible steps that can be undertaken by different players to lower trade-related transaction costs, as part of the ongoing efforts by the Palestinian Authority (PA) to transform the Palestinian economy into an investment-friendly environment for the domestic private sector and international investors, and the chapter ends with some concluding remarks.

The Role of Transaction Costs in the Economy

Transaction costs are the costs of running an economic system and, as such, are unavoidable. It is widely recognized, however, that excessively high transaction costs impede the process of diversification, export growth, and private investment in developing economies. Broadly defined, transaction costs refer to all costs involved in creating and operating institutions underlying the processes of production and exchange in the economy, including search and bargaining costs, and costs of coordination between and within institutions and organizations.1

Transaction costs arise mainly in connection with the exchange process. Modern industrialized economies depend on a complex structure of individual specialization and exchange over time and space, and use elaborate institutional structures (such as formal contracts, guarantees, brand names, monitoring systems, and effective enforcement mechanisms) to ensure that individuals and firms adhere to the “rules of the game.” These institutional structures create considerable transaction costs, but the productivity associated with the gains from trade is even greater.2 Not all transaction costs can be justified, however, on efficiency or equity grounds. While those incurred in reducing information failures and risk of default raise efficiency, those that result from excessive regulations and nontransparent legal systems are clearly inefficient and can perpetuate inequities and lack of competitiveness in the business environment. They can also prompt the private sector to resort to informal arrangements to contain risk, to avoid long-term contracts, and to hire facilitators to deal with the inefficiencies of existing institutions (see Box 3.1).3

The performance of the Palestinian economy is hampered by the trade-related cumbersome and complex system of permits, security checks, transportation procedures and fees, and the considerable uncertainty surrounding their implementation in practice. These restrictions, which are largely unique to the West Bank and Gaza, raise transaction costs significantly, including the cost of obtaining information about, and dealing with the various rules and regulations governing trade and transportation.4 The Palestinian economy is further hampered by restricted access to external markets, inadequate infrastructure (including utilities), a complex legal and regulatory framework, a weak judicial system, red tape and governance issues, and limited access to financing, all important factors that raise transaction costs.5

Increased transparency of public procedures, deregulation, trade liberalization, and technical progress can significantly reduce many transaction related costs that are common in developing economies like the West Bank and Gaza.6 The emphasis placed on regulatory and legal reforms is based on the recognition that while sound macroeconomic policies matter for investment and growth, it must be supported by institutions that ensure transaction costs are not inhibitive to investment and growth. Thus, the focus of the PA economic policy framework (EPF) described in Chapter 1 goes beyond an improvement in fiscal management to also include enhanced transparency and governance in the PA’s financial operations, the opening to the private sector of economic activities currently carried out by the PA, improved banking supervision, and strengthened legal and regulatory frameworks. The intention of the PA is to subsequently incorporate in the EPF other reforms to strengthen the institutions that shape the business environment. Such reforms, however, do not directly address the additional trade-related transaction costs cited above that are unique to the Palestinian economy. The rest of this chapter will focus on describing, in some detail, the nature and scope of these costs and suggesting specific measures for reducing them.

Rules and Restrictions Governing Domestic and External Trade

For security reasons, trade to and from, and even within the West Bank and Gaza, as well as between the West Bank and the Gaza Strip is strictly regulated by the Israeli government. A complex system of permits, fees, security inspections, and transport restrictions severely constrains the movement of goods and people, raises costs considerably, and causes substantial delays.7 (see Box 3.2).

Box 3.1.Transaction Costs in International Trade

There are many types of transaction costs that usually arise in the exchange of goods and services between countries. These include: (i) the costs of obtaining information about local and foreign markets; (ii) the costs of information about government regulations and policies (such as exchange rate policy, exchange restrictions, tariff and nontariff barriers, and health and environmental regulations); (iii) costs of identifying trading partners; (iv) costs of negotiating, writing, and enforcing contracts and resolving disputes between parties; and (v) the costs of financing transactions, including the risk of default throughout the long process of receiving an export order and being paid for it (Abdel-Latif and Nugent, 1996).

Although transaction costs are unavoidable in international trade, what matters is whether their presence and level are justifiable on efficiency grounds. Thus, on the one hand, the costs of setting up and running institutions and arrangements that improve the availability and processing of information or reduce risk of default, for example, are cases where transaction costs have to be incurred to enhance efficiency. On the other hand, excessive additional transaction costs sometimes have to be incurred due to dysfunctional regulatory and legal systems or can arise through channels of rent-seeking behavior in state-business relations. In the absence of transparent formal institutions, the tendency to resort to informal arrangements (including side payments and bribes) or hiring facilitators at points of contact with authorities can become a rational response by the private sector to circumvent tedious regulations. These activities in themselves raise transaction costs and constitute second best solutions when compared to conducting transactions under a streamlined and efficient institutional framework.

Inadequate public institutions, especially the legal system, can play a vital role in inhibiting the ability of the private sector to enter into trade contracts with confidence and may lead to inequities. Where political considerations have prevented private institutions from replacing public ones, transactions and contracts tend to occur only in closed circles of people who know each other or who are well connected and have insider knowledge and access to resources to circumvent stringent regulations. This can help create an insider-outsider business environment that perpetuates particular patterns of income distribution and makes it difficult to establish new businesses (Holden and Rajapatirana, 1995).

Many factors can influence transaction costs involved in trade. Costs can be raised by: (i) use of nontariff barriers to trade, which are subject to more abrupt changes over time than other tariff barriers; (ii) asymmetry of information that characterizes many relationships leading to adverse selection and moral hazard problems; (iii) differences in language, culture, taste, laws, and dispute resolution procedures; (iv) difficulties of enforcing contracts across countries and, hence, higher risk of payment default; (v) quality differentiation and increasingly specialized products for which distinguishing between contract fulfillment and nonfulfillment is difficult (Abdel-Latif and Nugent, 1996). On the other hand, transaction costs can significantly be reduced by: (i) transparent rules and regulations related to trade transactions; (ii) technical progress; (iii) trade liberalization; (iv) transparent legal and judicial procedures; (v) efficient civil service and good governance structures; and (vi) a clear division between the role of the state and the private sector in the economy.

There is a widespread perception among Palestinian business people that the transaction costs of conducting trade are excessively high and that they are mainly due to the security-related regulations.8 This perception came out clearly during discussions with PA officials and private sector representatives, and in a recent study on private sector performance and the obstacles it faces in international trade.9 This study finds that most of the rather substantial differences in costs between Israeli and Palestinian businesses of conducting identical trade transactions arise from the unequal treatment of Palestinian goods, for example, as regards issuing vehicle permits, transportation restrictions, security checks, and the fact that Palestinian business people must deal with two layers of bureaucracy in seeking trade licenses and fulfilling other administrative requirements to conduct trade. The study also mentions that other contributing factors to the high level of transaction costs are: the lack of trade promotion by the PA, in the sense of facilitating information to local business people and assisting them in establishing contacts with foreign counterparts; insufficient development of export strategies by the Palestinian private sector; and inadequate supporting institutions, such as traders associations and chambers of commerce.

Box 3.2.Export and Import Regulations in the West Bank and Gaza

Exports do not normally require licenses, but certain categories of goods, which need to fulfill standards and other controls, must have an authorization that is given in the form of a license once the requirements have been fulfilled. The goods include foodstuffs and chemicals, which must be authorized by the Ministry of Health, and agricultural products, for which the authorization is provided by the Ministry of Agriculture and is valid for a single shipment or for a season, if a seasonal registration has been requested prior to applying for the export authorization. The same ministry grants the phytosanitary certificate following a one-day check, which is free of charge.

Certificates of origin are required to benefit from preferential tariff treatment under the trade agreements with the European Union (EU), the United States, Canada, Jordan, Egypt, and Saudi Arabia. These certificates provide the proof that the goods are entitled to duty-free entrance because they comply with the rules of origin. The administrative requirements under the various agreements to secure the preferential treatment diverge significantly. For goods destined to the EU or EFTA countries, the certificate of origin (EUR I), obtainable at the Customs Department of the PA Ministry of Finance and at the Chamber of Commerce, must be typed in English and include the exporter’s signature and seal, and to be valid, it must be stamped by the Customs Department, which ascertains compliance with the rule of origin at no charge. It should also be accompanied by the commercial invoice and the packing list. Any mistake in this list can cause a delay in clearance at the port of destination until the importer satisfactorily completes it. For goods destined to the United States, the certificate of origin is called form A and must also be accompanied by the same documents as for the EU, plus a customs form (CF7501) and a special permission for direct delivery to the United States (form CF316). Finally, goods destined to the Arab countries, require that the certificate of origin be stamped by the Ministry of Economy and Trade and the Chamber of Commerce, which requires from the importer the commercial invoice, the corporate registration, and the foreign trade dealing registration.

Imports: Before goods can be imported an import license and, if applicable, a standards certificate and sanitary and phytosanitary certificates must be obtained. The former certifies that the goods to be imported are within the allowed quotas of lists A1, A2, and B, while the latter certifies that the product complies with the required quality and health standards. The import license can be obtained by the importing enterprise (or its designated clearing agent) from the relevant Israeli and Palestinian ministries or agencies. Import licenses mainly apply to: (i) goods subject to quotas (for example, agricultural goods and other goods from the lists A1, A2 and B as agreed in the Paris Protocol); (ii) goods subject to public health restrictions (that is, meat, foodstuffs and pharmaceuticals); (iii) petroleum and gas, telecommunications equipment, and motor vehicles; and (iv) goods classified as “L” in the Israeli Tariff Book (for example, fresh vegetables, processed agricultural products, and processed foodstuffs; live animals and animal products; arms and defense-related goods, certain industrial and agricultural machinery, and leather goods). Approval from specific Palestinian ministries or agencies is required for the following products prior to the issuance of the license: General Petroleum Corporation (petroleum products); Palestinian Tobacco Authority (cigarettes and tobacco); Environment Department (insecticide and paint products); Ministry of Transportation (motor vehicles and related spare parts); Ministry of Post and Telecommunications (telecommunication items); Ministry of Agriculture (agriculture products and food items); and Ministry of Health (pharmaceuticals and chemicals). The import licenses are free of charge, but their applications may require two or more weeks for processing and must be filled in four copies (two in Arabic-English and two in English-Hebrew). In general, the import license is issued for a single type of good and a specific quantity, and it has a time limit depending on the product.

To obtain a standard certificate, the importer has to submit a sample product (prototype) together with its specifications to the Palestinian (or Israeli) Standard Institute for testing, depending on the imported good and the ability of the laboratories accredited by the Palestinian Standards Institute to conduct the test. The certificates must be obtained for each product type. They cost NIS 5,000 and are valid for any further import of the same type of goods for four years. After arrival of the shipment, products are tested for compliance with the prototype approval, but to avoid possible damage and the expenses arising from keeping the shipment at the port or in bonded houses, the Customs Authority allows clearance subject to the provision by the importer of a bank guarantee and a signed pledge that the products will not be distributed until the receipt of the type approval. This approval may take between 3–4 days for simple electronic goods to 3–4 months for more complex products such as refrigerators.

Goods for which standard certificates are required include food, chemicals and electrical goods, construction material, mechanics, power and hydraulics devices, quality systems, paper and leather. Failure to obtain the required import licenses and standards certificates may significantly delay the import of the shipment.

Gaining an understanding of the complex trade-related regulations is difficult because of the frequency and unpredictability with which changes are introduced.10 As a result, there is always an absence of up-to-date and widely accessible written material. The regulations and procedures described below provide a picture of the situation as of August 2000, including aspects related to security and customs clearing. They may have changed by the time of this paper’s publication, particularly because of the recent turmoil. Nevertheless, the purpose of this section is to illustrate the complexity of the rules that the Palestinian private sector is confronted with in conducting its day-to-day trade operations.

Routes for Domestic and Foreign Trade in the West Bank and Gaza

The regulations governing the movement of Palestinian trade need to be explained in relation to the geographical configuration of the West Bank and Gaza and means of access by the Palestinian economy to Israel and third countries for conducting trade. The West Bank and Gaza comprises two unconnected geographical territories: the Gaza Strip (360 square kilometers) and the West Bank, roughly 16 times larger. The West Bank is landlocked and bounded by Jordan on the east and Israel on the three remaining sides, and presently consists of various non-contiguous self-rule areas.11 The Gaza Strip is bounded by the Mediterranean sea on the West, Egypt on the South, and Israel on the remaining sides. There is no direct access to third countries by air, land, or sea, however, and Palestinian trade is conducted either via the ports and airport in Israel or via the crossing points with Jordan and Egypt, which Israel controls under the Interim Agreement (Map 1 and Box 3.3). The goods must be transported by road from and to each of these exit and entry gateways through a road network over which the PA has limited control.12 At all of the crossing points, goods are inspected by Israeli security and customs officials; Palestinian customs staff are only present at Erez, Karni, Rafah, and Allenby. There is no maritime transportation from Gaza because the construction of the deep-water seaport has been delayed. Air transport from Gaza, which started with the construction of the international airport in Rafah in 1998, is mainly used for passenger travel; passengers and goods using this airport are subject to Israeli immigration, customs, and security controls. Cargo operations have not yet started mainly on account of delays in the construction of adequate infrastructure facilities

There are five crossing points from Gaza. Erez and Karni are used for all Gaza trade with the West Bank and with or via Israel, except for the imports of petroleum products and construction materials from Israel.13 These products transit through the Nahal Oz and Soufah crossings, respectively. The Rafah crossing point is intended in principle for all Palestinian trade with or via Egypt, but it is very rarely used for exports from the West Bank because it would involve first going through the Erez or Karni crossing which makes this alternative too costly. Most of the foreign trade of the West Bank (with countries other than Israel) is conducted through the airport and seaports in Israel, or through the Allenby and Damya crossing points to Jordan. These crossings are also used for Gaza trade with or via Jordan.

Box 3.3.Moving Palestinian Domestic and Foreign Trade: Crossing Points, Ports, and Routes

1. Crossing points

Between Gaza with or through the West Bank, Israel, and Egypt

  • From or into Gaza for trade with the West Bank and with/through IsraelGaza/Israel: Beit Hanoun/Erez; Al Muntar/Karni; Nahal Oz; and Qarara (Soufa)Gaza/Egypt: Rafah (Rafi’ah Yam), also called Al-Awdeh
  • From or into the West Bank for trade with/through JordanAllenby bridge, also called Al-Karameh or King Hussein bridgeDamya (Adam) bridge, also called Prince Mohammed bridge

Between Israel and Jordan and between Israel and Egypt

  • From or into Israel for trade with/through JordanSheikh Hussein bridge, and Harava (near the Jordanian port Aqaba at the Red Sea)
  • From or into Israel for trade with/through EgyptNitsana (Taba)

2. Airport in Gaza

3. Ports and airport in Israel

  • Ashdod port, Haifa port, Eilat port (port at Red Sea); and Ben Gurion airport

4. Land transport routes designated for Gaza trade with/through Jordan

  • Erez-Beer Sheva road-Hebron-Bethlehem-Wadi Al-Nar-Jericho
  • Erez-Ashqelon-Latrun-Jerusalem (Giv’at Ze’ev Junction)-Jericho

A sense of the relative importance of the above crossing points is provided by examining the total trade conducted through them in 1999. Of this trade (US$712 million), which excludes trade of the West Bank with Israel and imports of water and electricity, the breakdown by crossing was as follows: Erez, 56.7 percent; Karni, 19.3 percent; Nahal Oz, 13.4 percent; Allenby, 4.9 percent; Rafah, 3.2 percent; and Damya, 1.8 percent. The trade composition between Erez and Karni is likely to have changed in the year 2000, reflecting the rerouting to Karni of an important amount of trade formerly passing through Erez.

In addition to the above international routes—and in order to avoid the delays associated with going through Allenby, Damya, and Rafah—some Palestinian trade is conducted through two crossing points intended for Israeli trade with Jordan (the Sheikh Hussein bridge and Harava) and Egypt (Nitsana). The use of these longer routes entails, however, reliance on Israeli intermediaries and transportation companies since Palestinians are not supposed to conduct trade through these crossings.

Transport Regulations and Procedures

Complex rules govern the transport of goods to and from the West Bank, Jerusalem, Israel, and Gaza. Palestinian (registered) vehicles and drivers need permits, which vary in duration.14 The process of obtaining a permit may take several weeks.15 According to the FPCCIA (1998) study, the insufficient number of vehicle permits makes it inconvenient and costly for business people to travel to the Israeli ports of entry, preventing them from becoming familiar with the complex clearing process (involving customs and security checks), which would help to speed it up. Also, the use of the Gaza airport is not convenient for business people residing in the West Bank because of difficulties in obtaining special permits to travel to Gaza, an obstacle that also limits trade between the West Bank and Gaza.

The regulations for vehicles used in trade include restrictions on the type of trucks that are allowed, the roads that can be used, and the goods that can be transported. Some rules differ depending on the nature of the goods, destination, or origin of the cargo. For example, imports of cement or petrol are subject to less restrictive rules than perishable goods, which in turn are treated differently from manufactured goods.16 Certain trucks are only allowed to transport goods in one direction forcing them to travel one way empty. These limitations compel Palestinian companies to use Israeli trucking companies to transport the goods from and to their factories, at a rental cost that is significantly higher than using factory-owned trucks (FPCCIA, 1998).

Palestinian-registered transport vehicles are prohibited from entering Israel, except under certain conditions and with special permits, as explained below. This ban is at the origin of a complex and costly transit system known as back-to-back, where by Palestinian trucks arriving at one side of the crossing point must unload the goods for inspection by Israeli security, for subsequent reloading onto an Israeli truck at the other side of the border. These unloading and reloading operations are exclusively undertaken by Israeli companies. A similar exclusivity applies to the customs clearing function as Palestinian clearing agents are not allowed to enter Israel’s ports of entry.

The special permits granted to Palestinian trucks by the Israeli government to enter Israel or its ports of entry carry the obligation that the trucks move in a convoy under Israeli security, except for sterilized trucks (see below). After an inspection by Israeli security at the crossing point in Gaza, groups of empty trucks with their permits are escorted nonstop by Israeli security to the ports of Ashdod and Haifa, and Ben Gurion airport. 17 Under the convoy system, trucks must travel one way empty. The advantage of the convoy is that the trucks can enter Gaza without having to unload the goods at the crossing point. Before the trucks can exit Gaza again, however, a security check is conducted. Convoys may consist of green trucks (see below) and regular trucks.

Palestinian sterilized trucks are allowed to operate in Israel subject to certain conditions. According to the PA Ministry of Economy and Trade, after a security check, these trucks (about 200 trucks registered in Gaza and in the West Bank) are considered to have been “sterilized,” that is, cleared for operation on Israeli roads. The authorization granted to these trucks is valid for two months during which they must remain in Israel. For this reason, these trucks never enter Gaza. They are allowed to pick up the goods that other Palestinian trucks deliver from the Gaza Strip at the crossing point, but transport of the goods is still subject to restrictions.18 For example, the trucks stay overnight in a special fenced parking compound at the Israeli side of the crossing point under Israeli supervision; they are required to arrive at this area by 7:00 p.m., and failure to do so triggers another security reexamination under a procedure that can take several days. The drivers of these trucks can spend their nights in Gaza, from where they leave early in the morning after undergoing the routine security checks at the crossing point. Permits for sterilized trucks cost NIS 500 for trailers and NIS 400 for smaller trucks, regardless of the volume of transport. These fees accrue to the Israeli government.

The green trucks, often also referred to as “stripped,” “open,” or “skeleton” trucks, operate in both Gaza and the West Bank and are the only trucks allowed to cross the border with Jordan. The big advantage of the green trucks is that once their cargo has been checked and cleared at the crossing point in Gaza, they can go directly to Jordan by crossing at Damya. These trucks must also observe strict timetables for their return to designated points. According to the UNCTAD study (1999), to facilitate the security inspection, these trucks must, however, comply with the following strict Israeli specifications: (i) the load area and the engine must remain uncovered; (ii) the fuel tank cap must not have a lock; (iii) the dashboard must be limited to a speedometer and the fuel gauge; and (iv) the driver’s seat must be made of metal bars and no second seat is allowed. Moreover, a lead seal by Israel on tires and external screws is required. Hence, the major disadvantages of the green trucks are that they are slow, uncomfortable, relatively unsafe, unable to protect the cargo from dust, and are particularly inappropriate for hot days due to the lack of air conditioning and the heat coming from the uncovered engine, rendering them unsuitable for the transport of perishable goods. According to the PA Ministry of Economy and Trade, as of August 2000, the initial fleet of 320 green trucks dating from 1967 had been reduced by about half and it is estimated that only about 90 trucks were in operation.19 In the last two years, 40 of these trucks have been granted a special permit to operate at Allenby, allowing a more speedy cross-border transport of agricultural products (citrus, in particular) from Gaza to Jordan. The trucks go to Amman to unload their cargo and are kept sterile by parking outside Allenby, where they must arrive by 4:00 p.m. everyday to avoid losing their status.

Moving Goods Through Selected Crossing Points

This section describes the regulations and procedures for the transport of cargo through the Erez and Karni crossings, which are the obligatory passage for Gaza trade with the West Bank and Israel’s ports and airport, as well as for trade that comes from or goes to the crossing points with Jordan. It also provides a detailed description of the steps involved in arranging for the passage of imports through the Allenby crossing with Jordan and touches briefly on the procedures applicable to other crossings.

Trade Through Erez and Karni Crossing Points

The regulations and procedures for the transport of goods through Erez and Karni crossing points described below refer to exports from Gaza; those applicable to trade in the opposite direction are also described only to the extent that there are differences. Within Gaza, all transport is usually done with Palestinian trucks. At the crossing point, the exporter has the option of using: (i) Israeli licensed trucks, to which goods from the Palestinian trucks must be moved back-to-back before entering Israel and vice versa for goods arriving at the crossing point in Israeli trucks; or (ii) Palestinian trucks, which are more affordable but are subject to more frequent security-related delays, including along the way to their final destination.20 As noted above, except for the sterilized trucks, Palestinian trucks operating in Israeli territory must move in a convoy escorted by Israeli security all the way to Israeli ports or to the designated point for goods intended for exports to or via Jordan.21 The same system is used for trade in the opposite direction, requiring that the trucks leave Gaza empty when they go to pick up their cargo and deliver it to Gaza at the Israeli inspection area to be reloaded again after inspection.

Goods transported on green trucks, either from Gaza or the West Bank with final destination in Jordan, are delivered via Damya or Allenby to Al-Shouna in Jordan for a back-to-back transfer to Jordanian trucks. The crossing with Jordan is done without further security checks and the goods are merely inspected for customs (UNCTAD, 1999). According to the PA Ministry of Economy and Trade, green trucks that go to Al-Shouna have to be back to their designated locations in the West Bank and Gaza by 4:00 p.m. the same day. In order to meet the time requirement and ensure delivery of the cargo at the designated point on the same day, trucks usually leave Gaza very early in the morning (4:00–6:00 a.m.). Trucks that start their journey with insufficient time to go as far as Al-Shouna and be back on time, unload their goods immediately after crossing the bridge. Because of the time restrictions and bad physical conditions of the green trucks, many exporters chose to use non-green trucks, even though this involves an additional off-and-on load operation in Jericho.

According to the PA Ministry of Economy and Trade, when sterilized trucks are used, they start off empty from the Gaza checkpoints on the authorized date and time to the place from where they have to pick up their cargo. In principle, the trucks are also allowed to pick up goods at Allenby or Damya bridges.22 When these trucks return to Gaza transporting goods, they must first go through Karni, unload the cargo for inspection and transfer it to a Palestinian truck for final delivery. The empty sterilized trucks go to the security zone at Erez, where they must arrive by 7:00 p.m. at the latest. The lengthy administrative and security procedures at Allenby may prevent the trucks from going through Karni and arriving at the security zone in time. In this case, the drivers leave the trucks with their cargo at Erez until the following day.

According to PA officials and private sector representatives, the inspection of vehicles and goods from Gaza usually takes several hours. Goods going through Erez or Karni are inspected at the crossing point except for goods in or out of the Gaza Industrial Estate (GIE), for which special arrangements are in place (see the next section below).23 At Karni, the trucks are unloaded and the merchandise is put on pallets that go through x-ray machines (The Services Group, 2000 and Jackson, 2000). Goods that pass the security check are transferred to the trucks waiting at the other side of the crossing. The crossing point is usually open between 8:00 a.m. to 12:00 midnight and does not operate for cargo on Fridays and Saturdays. 24 Operational difficulties have produced delays during the peak periods of agricultural produce trade. A crossing charge of NIS 400 per vehicle (shared between Israel and the PA) has to be paid at Karni, no such fee is charged at Erez, while the use of the convoy system, not allowed at Karni, represents a less costly alternative. 25 The cost of arranging for a 15-truck convoy is NIS 1,500.26 Palestinian exporters often complain about the damage to the merchandise inflicted by security checking procedures, as noted in Box 3.4 on the export of perishables.

Using Damya or Allenby Crossing Points with Jordan

As noted earlier, these two crossing points are used for Gaza and West Bank trade with or through Jordan.27 This section illustrates the steps involved in arranging for the passage of imports through Allenby. While import procedures are broadly the same when other crossing points are used, imports through Allenby involve payments of higher fees, such as for coordination and crossing, and different packaging requirements. According to PA officials and UNCTAD (1999), the import procedures may be summarized as follows:

Box 3.4.Exporting Perishable Goods from Gaza to Europe: Strawberries and Flowers1

Administrative procedures: the cooperatives present their export plans to the marketing directorate at the PA Ministry of Agriculture, which informs the Israeli authorities of the proposed volume and date of export. If the goods are authorized for export, the Israeli authorities indicate the day and time at which the vehicle carrying the merchandise must be at Erez in order to join other trucks that will be part of the convoy. Arranging a convoy usually takes between five to ten days and it is done through the Palestinian Ministry of Civil Affairs. The loaded trucks go to Erez for vehicle inspection under a process that may take several hours. Following this inspection, the trucks wait for other trucks required to constitute a convoy. The cost of a 15-truck convoy is NIS 1,500. The goods are taken to a distance of about 30–35 kilometers away from Erez to two different Israeli inspection points (Yanai-Asata or Cokhav-Akdarot, one is for flowers and one for strawberries) where they are unloaded onto Israeli trucks for security checking and sorting before proceeding to Ben Gurion airport. A large portion of Gazan agricultural exports is conducted through the Israeli agricultural marketing board AGREXCO, which charges two sets of fees to the farmers, including 3.5 percent of the f.o.b. (free on board) value of the merchandise. Similar exports to Egypt through Rafah have not met with success owing to the lack of adequate transportation facilities from Rafah to Cairo.

Flowers: The security inspection is done package by package. From the day in which the flower is cut it can last up to two weeks, but to avoid the potential delays in the security procedures, farmers only cultivate flowers with longer lives for exports. The flowers are exported as Palestinian goods; the volume of production is estimated at about 2,000 tons per year. Security and transport (especially by land to Tel Aviv) can add considerably to the total cost of exporting these flowers as illustrated by the following example: the farmgate price of Gazan flowers exported to Europe is $3,300 per ton. Transport and security checks raise the farmgate price by an additional US$980 per ton, which for each ton consist of $30 for land transport to Tel Aviv (about 75 km), US$150 for inspection cost and $800 for air transport from Tel Aviv to Europe (about 3,311 km). This amounts to a cost of US$0.40/km for land transport (rising to US$2/km if we add security checks), compared to only US$0.24/km for air transport. Given that air cargo is generally much more expensive than truck freight, this example helps illustrate how land transport to the airport plus inspection costs constitute an inordinately high segment of total costs of exporting flowers in Gaza.

Strawberries: The strawberries are transported, on the day they are picked, from the farm to the security checking point where the cartons are inspected individually with a security glove. If the vehicle does not pass the inspection check, the entire convoy may be returned to Erez for another inspection. Unlike flowers, the merchandise is also examined for quality and is repackaged for exports. At this point, the merchandise may be thrown away or sold in the Israeli markets when found unsuitable for exports (traces of insecticide for example). Proof of this unsuitability takes the form of pictures provided by AGREXCO to the farmers since they are not authorized to be present during the sorting procedure. The farmers are paid an amount net of commission but are not always aware of the negotiated export price; they have qualified their export operation as profitable because the current marketing arrangement facilitates access to the otherwise difficult and costly air transportation, and prevents the frequent delays and damage to products during inspection and cargo handling. At the same time, this system deprives them of the opportunity to establish an export reputation in foreign markets.

1Information based on discussions with representatives from the Ministry of Agriculture in Gaza.

(i) The importer makes a reservation at the Palestinian Ministry of Civil Affairs (PMCA) a week in advance of the arrival of the goods. Typically, about 15–20 trucks are allowed daily for imports under a coordination system that exists between the PMCA and Israeli security.28 The coordination fee is about US$30 (NIS 120), The importer provides the clearing agent with all the relevant documentation to prepare the customs formalities. In addition, to a copy of the invoice and the documents specified in Box 3.3, the documentation must provide information on the truck and driver. As noted earlier, only Israeli agents are permitted to conduct clearing and they must be present throughout the security process, which may last several hours. Palestinian agents are authorized to conduct the forwarding process but because the two tasks are usually done jointly, the Palestinian business people end up paying higher prices for the combined operation (FPCCIA, 1998).

(ii) Once the goods arrive at the Jordanian border and have passed all the Jordanian customs procedures, the Israeli customs will allow the Jordanian driver to cross the bridge. The cargo is then off-loaded by an Israeli company for inspection. After the inspection, the cargo will be reloaded onto a Palestinian or Israeli truck, which will cross the checkpoint for Palestinian customs and tax clearance prior to proceeding to the final destination (UNCTAD, 1999).

Trade Through Other Crossing Points

The procedures followed for customs and security inspection at the Rafah crossing with Egypt are roughly similar to those at Allenby, explained above. They involve the use of an Israeli clearing agent and an Israeli company to prepare the goods for customs and security inspection and load the cargo onto Egyptian trucks. This is followed by Egyptian customs clearance and a security inspection. Imports destined for Gaza are transported directly to the importer while those destined for the West Bank need to go through the transportation and security procedures at the crossing points in Gaza and entry into Israel, which were explained above (UNCTAD, 1999). Rafah is rarely used for exports from the West Bank, mostly due to cost considerations and because of limited trade with Egypt.29 Trade between the West Bank and Egypt is conducted through the Taba (Nitzana) border crossing point. The use of this crossing avoids the long cargo procedures through Karni and Rafah, which would entail two back-to-back procedures and increase the risk of merchandise damage.

Trading Through Israeli Ports and Airport

The procedures governing trade through Israeli ports and airport explained in this section, which apply to all Palestinian trade, relies on information by the PA Ministry of Economy and Trade and on the FPCCIA study (1998), based on a numerical example comparing the time and cost involved in sending an export shipment from Ramallah to Athens in a passenger plane versus a cargo plane. At the Ben Gurion airport, Palestinian companies unlike Israeli companies are not allowed to transport their goods on passenger planes and must therefore rely on cargo planes. In contrast to passenger planes, cargo planes have less frequent flights and fewer direct destinations and are, consequently, more costly (more than double). In addition, the waiting period to get a slot in the plane is longer for cargo than for passenger planes. For these reasons, the above-mentioned study finds that the overall cost and time differentials, are respectively, 39 percent and over 75 percent higher for a passenger plane than for a cargo plane (Figure 3.1). Given these differentials and the damage that occurs during inspection and cargo handling, producers of Gaza exports of perishable goods, which must be transported by air, find it more effective to use Israeli traders pending an expansion in the administrative and logistic infrastructure of the Gaza airport to facilitate trade (see Box 3.4).

Figure 3.1An Export Shipment to Greece from Ben Gurion Airport

Source: Federation of Palestinian Chambers of Commerce, Industry, and Agriculture, 1998.

The Palestinian Export/Import Guide of the PA Ministry of Economy and Trade (1999) describes the security controls for Palestinian imports at Ben Gurion international airport as follows: security controls take place twice, once when the airplane arrives and again upon conclusion of the clearing process. The goods must, however, remain at the airport for at least 24 hours before the second inspection can be conducted. Electronic detectors are used during the first procedure, but during the second, cases are opened. A payment of about US$30 per hour of labor must be paid by the importer for the second security control, on account of the loading/unloading services provided by a specialized company. According to private sector representatives, security controls take longer for Palestinian trade than for Israeli trade, thus resulting in higher costs.

At the Ashdod and Haifa ports, goods are also subject to the double inspection undertaken at the airport and the importer must also pay the same hourly rate for the second inspection. The study by the FPCCIA (1998) notes that the level of efficiency in conducting the inspections is, however, superior at Ashdod reflecting better infrastructure (inspection equipment, sheltered parking lots, trained examiners, and other personnel in a sufficient number) that ensures a prompt start of the inspection, a moderate checking policy covering 10–25 percent of the cargo, and the presence of a mediator between the port and PA companies who assists with advice and coordination of truck flows. The study also indicates that at Haifa, nearly all of Palestinian import cargo is checked. In contrast, the modern international customs administration practice of checking between 3 to 5 percent of imports is followed for Israeli trade.

Quantifying Some of the Trade-Related Transaction Costs

The restrictive trade environment described above has imposed costs of varying nature on Palestinian trade, not all of them quantifiable. For example, in an effort to ensure a less interrupted transport of goods, many Palestinian business people have entered into various forms of equity participation in Israeli trucking companies, although the cost of labor in Israel is more expensive than in the West Bank and Gaza. The choice has been based on the net gain arising from both predictability of the time required to process the imported goods and the ability to render exports competitive in a just-in-time delivery environment. Not all Palestinian business people, however, have the means or contacts to avail themselves of such arrangements and must either hire Israeli registered vehicles or cope with delays in the trade process.30 One side effect of using Israeli-registered trucks is that the development of the Palestinian trucking industry is constrained.

The Palestinian private sector also uses Israeli intermediaries and marketing agencies for exports of Gazan perishables to facilitate trade, through lower air transport and distribution costs, and to reduce the risk of merchandise damage. A consequence of this is that Palestinian business people do not acquire familiarity with marketing techniques and forego the possibility of establishing direct export links.

The following sections provide examples of the costs incurred in conducting trade through Allenby and Haifa. The first example is based on discussions with PA officials and private sector representatives and the last two on the study by the FPCCIA (1998). This study concluded on the basis of information gathered on actual transactions, that, on average, the transaction costs (including inland transport) and delays incurred by Palestinian business people when doing business with the rest of the world are, respectively, 30 percent and 45 percent higher than for their Israeli counterparts.

The Costs Arising from Border Procedures for Imports from Jordan via Allenby

It is costly and time consuming to move merchandise through the Allenby bridge mainly because of the security procedures and other restrictions, and fees payable to both the PA and Israel. The complexity of the process is compounded by other factors including, the lack of adequate customs clearing and laboratory facilities, the limited hours of operations, and the absence of bonded customs areas. The costs that arise from the above procedure for an import shipment are shown in Table 3.1 and Figure 3.2.

Table 3.1Costs Incurred in Transporting and Clearing an Import Shipment from Jordan(In NIS)
Nature of Costs
Up to King Hussein Bridge447
Transport to the King Hussein Bridge (KHB)380
Clearance formalities at KHB67
Crossing Allenby Bridge919
Fees509
Coordinating fees (PA)120
Allenby Bridge
Entry fees (Israel)141
Entry fees (PA)128
Usage fees (PA)120
Off loading/loading charges (pallets) (US$5 each)380
Bank charges30
From Allenby to destination1,300
Clearance formalities after inspection1600
Inland transport700
Costs from Allenby to destination in the West Bank and Gaza2,219
Source: Ministry of Economy and Trade.

Depends on the value of the goods.

Source: Ministry of Economy and Trade.

Depends on the value of the goods.

Figure 3.2Costs Incurred in Transporting and Clearing an Import Shipment from Jordan

Source: Ministry of Economy and Trade.

The fees for crossing the bridge alone are about US$130, to which should be added the costs of delays incurred in the inspection process, the charges for loading/unloading and clearing services, and the frequent damage to the merchandise during the security inspections and handling. For stones, for example, the charges for handling and clearing services (US$150 for a given shipment) are estimated to be three times as high as at Ashdod.31 As a result, the cost of a shipment of stones from Bethlehem to Tokyo, for example, is virtually the same as the cost of a similar shipment to Amman, while the air distance is more than 100 times longer for Tokyo. In all, the costs, delays, and the risk of damage to the merchandise during the security inspection process render the transport of stone exports through Israel or Sheikh Hussein bridge cheaper, despite the higher fees charged by Israeli trucks.

Cost and Delay Differences Between Palestinian and Israeli Businesses Importing Via Haifa

FPCCIA (1998) compares the sources of cost differences and delays that may be incurred by Palestinian and Israeli companies in clearing and delivering to its final destination, an identical shipment of raw material from Italy through the Haifa port (see Table 3.2). Four scenarios of increasing costs and delays are considered. At one extreme, the first scenario assumes no surcharge by the clearing agent, no damage to the merchandise and no border closures, and at the other, the fourth scenario assumes the combined presence of all of these factors, including a 10-day closure.

Table 3.2An Import Shipment of Raw Material from Italy Via Haifa: Costs and Delays Incurred by a Palestinian Company Vis-á-Vis an Israeli CompanyValue (NIS) = 35,000Route: Italy-Haifa-Ramallah/Tel AvivWeight (tons) = 5CIF value = 37,140
Palestinian CompanyIsraeli Company
StepsCostsAmount (NIS)Delay (hr.)Amount (NIS)Delay (hr.)
Transport/loading ItalyTransportation and handling charge1,000481,00048
Shipping Italy/IsraelSea freight Italy/Israel2,000722,00072
Insurance (0.4% of value)140140
Arrival and unloading in HaifaPort Fee (1.3% of value)455244S524
Stevedoring fee720720
Tariff00
VAT (17% based on CIF value)6,3146,314
Security checkAgent hours for security check6007200
Agent fee1% for PA company360360
0.6% for Israeli company
Loading truckWorkers’ services703702
Trucking to final destinationDriver and truck rental1,50051,5003
Total: Scenario 1 (impact of security check)13,15922412,559149
Agent surcharge15400
Total: Scenario 2 (impact of security check and agent surcharge)13,69922412,559149
DamageLost revenue from 1% damage27000
Total: Scenario 3 (impact of security check, agent surcharge and 1% damage)14,39922412,559149
Storage feeTotal charge for ten days over limit ($25+$0.4/kilo/day)372,900504
Total 4: Scenario 4 (impact of security check, agent surcharge. 1% damage, and 10-day closure)87,29972812,559149
Percentage difference (basis = Israeli side)
Scenario 1550
Scenario 2950
Scenario 31550
Scenario 4595389
Source: Federation of Chambers of Commerce (1998). Example 1 (including information provided in the footnotes below).

Some agents openly say they need to charge PA companies more for extra effort; in general anybody poorly informed about the system, tends to get overcharged by agents; the assumed differential is very conservative.

The sales price is assumed to be double the sourcing price

The closure is assumed to result in 10 days of storage costs above free storage limit.

Source: Federation of Chambers of Commerce (1998). Example 1 (including information provided in the footnotes below).

Some agents openly say they need to charge PA companies more for extra effort; in general anybody poorly informed about the system, tends to get overcharged by agents; the assumed differential is very conservative.

The sales price is assumed to be double the sourcing price

The closure is assumed to result in 10 days of storage costs above free storage limit.

Under the three non-closure scenarios, the time required by Palestinian companies to complete the clearing and delivery process is 50 percent higher than for Israeli companies. This differential is almost entirely due to the time required for the additional security checks, which also lead to payments that Israeli companies do not have to incur; Palestinian companies must hire a clearing agent representative to be present throughout the security checks. Taking into account the fees payable to the agent, the cost differential under the first scenario is 5 percent. The FPCCIA study (1998) mentions that it is not unusual for such agents to demand a surcharge in addition to their fees. Assuming that a surcharge is paid to the agent, as in the second scenario, the cost differential calculated by FPCCIA rises to 9 percent, and further to 15 percent under the third scenario, when merchandise damage equivalent to 1 percent of the sale price is incorporated into the exercise. Finally, under the closure scenario, storage fees alone could result in prohibitive costs driving the price differential up to nearly 600 percent.32

Reducing Transaction Costs and Promoting Trade

The preceding sections have illustrated the adverse impact on the Palestinian trade environment and costs of the system of permits, fees, security check procedures, and transport restrictions and regulations. The effects of the closures in late 2000 and early 2001 have been covered in Chapter 1. A key question for the future is how to minimize these costs in general, and those related to security in particular, in a situation where security will remain a concern. And what is the role of the different players involved in the trade process to achieve this objective and improve, in a meaningful and lasting manner, the conditions under which trade takes place?

The first imperative is to allow free movement of goods and people by raising the level of efficiency and effectiveness of security checks. At the same time, the Palestinian economy needs to count on other means of access to third countries and a permanent passage linking the West Bank and Gaza. Also, the administrative infrastructure for trade needs to be improved to render the trade process simpler, more transparent, and predictable. Finally, the Palestinian private sector has recently stressed the need for larger involvement by the PA and private sector associations in promoting trade, and for private firms to pursue strategies geared towards increased competitiveness. These points are developed below.

Reducing Security and Trade-Related Transaction Costs

The question about transaction costs related to securiry is to increase the efficiency and effectiveness of the inspection methods and techniques so that trade can be conducted uninterrupted. Advanced technology should be adopted to the maximum extent possible. Proposals to this effect are discussed below. As regards other costs incurred in trade, an example of a low cost and quick-to-implement saving measure would be the elimination of passage fees at Allenby, which are not consistent with the quality of the services provided. Currently, a large portion of those fees accrue to the PA, which could eliminate them unilaterally (see Figure 3.2). A proposal by USAID to introduce truck scanner machines (see below) would be grant financed, and if fees are to be charged for maintenance purposes, they are unlikely to be as high as current charges at Allenby.

Box 3.5.The Gaza Industrial Estate and Comparative Benchmarking with Competing Export Processing Zones in the Region1

The Gaza Industrial Estate (GIE) was established in 1999, under the provisions of the Industrial Estates and industrial Free Zones Law (Law No. 1011998 of 1998), to enhance industrial development and attract local and foreign investment in Gaza. It is managed and operated by a private company: the Palestinian Industrial Estate Development and Management Company (PIEDCO). The GIE external infrastructure was financed through foreign aid, whereas the internal infrastructure (buildings, back-up energy, and water sources) was financed by PIEDCO. Although the GIE is not limited to exporting industries only, it is mainly targeting foreign investors with export potential. Only environmental considerations determine whether an investment is accepted or rejected. As of September 2000, 50 companies had license to operate in the GIE, out of which 38 were actually operating and 12 were still under construction. Of the operating companies, 15 were Israeli. Total employment was about 1,800, mostly Palestinians. PIEDCO plans to construct eight additional industrial estates in the West Bank and Gaza.

The Services Group, an American based consultancy firm, conducted a study comparing GIE and other possible industrial estates in the West Bank and Gaza with industrial estates in five countries of the region: Jordan (Al-Hassan Industrial Estate, Irbid), Israel (Matam Technology Park, Haifa), United Arab Emirates (Jebel Ali Free Zone, Dubai), Turkey (Aegean Free Zone, near Izmir) and Egypt (Port Said Free Zone). The study concluded that the West Bank and Gaza could be a prominent choice for foreign investors for some niche productions because it offered a number of important comparative advantages.

1. Access to foreign export markets. The West Bank and Gaza benefits from a preferential market access to the United States, Europe, and the Middle East region, although it shares this advantage with some of the other competitors. Considering the strong support that the West Bank and Gaza has from the donors community, it is likely that it will continue to benefit from preferential market access regardless of the trade regime that the PA finally adopts..

2. Investment incentives. The investment promotion law grants a general tax exemption of five years, and an additional 3–15 years in industrial estates depending on the importance of the project. Investments in industrial estates also benefit from duty-free privileges for both the fixed investment and spare parts (up to 15 percent of the capital investment). These incentives compare favorably with Jordan, Egypt, and Israel.

3. Skilled labor force. Although Jordan and Egypt have lower labor costs, the Palestinian high-skilled labor force is considered more productive. This is particularly true for engineers where the West Bank and Gaza were found to have the most competitive unit labor costs. For lower-skilled labor, productivity was found to be lower than in Jordan and Egypt.

4. Transportation facilities. From the logistics point of view, the Israeli ports (Haifa and Ashdod) and airports (Ben Gurion), offer the best infrastructure and facilities—currently used for trade in and out of the West Bank and Gaza—in the region. With the exception of Egypt for shipments to New York, sea transport costs from Israel are also the cheapest in the region. In contrast, Israeli air transport is relatively expensive, with prices for air freight to New York up to 85 percent higher than from Jordan (or 45 percent higher than from Turkey). However, the use of the Israeli seaports is more costly for Palestinians than for Israelis due to security-related delays (see below) and inspection fees; the study finds that the latter add some 5–18 percent to the transport and handling costs. While this infrastructure will remain, additional facilities will be added with the construction of the Gaza seaport and the use of the Gaza airport for freight.

Average Salary Levels for Unskilled Workers

(U.S. dollars per month)

The most important comparative disadvantages of the West Bank and Gaza as an investment place, according to the study, are:

1. Political risk and the cumbersome import and export procedures. Palestinian investment in just-in-time production is rather unattractive due to longer shipment delays caused by security inspections together with higher transport costs. The political risk has become evident during the 1995–96 closures and again with the recent turmoil that erupted in the fall of 2000. In an effort to limit political risk, the Law on Encouragement of Investment Law (Law No. 1 of 1998) guarantees investors against expropriation and nationalization, and guarantees the right to repatriate profits and to transfer ownership.

2. High utility costs. Water is scarce and largely under the control of Israel. Its price is only higher in Jordan. The power infrastructure is of high quality (using Israeli grid), its cost is higher than elsewhere in the region. With respect to telecommunications, the quality is on par with Egypt and Jordan but lower than in Israel, while costs of communication (especially for advanced services and for international calls to the Arab neighbors) is higher than among the competing locations. There is a potential and indeed a need for the West Bank and Gaza to substantially improve both the costs and quality of utilities in order to attract investment.

3. High infrastructure costs. Land and building lease rates as well as those for standard factory shells and office spaces throughout the West Bank and Gaza are relatively high when compared with the region.

In conclusion, and given its comparative advantages, the West Bank and Gaza is most likely to attract investors that produce high quality products for exports using a high proportion of skilled labor and do not rely on rapid transportation by either sea or air (pending substantial improvements in access and clearing procedures). Furthermore, investors would use the West Bank and Gaza’s unique advantage in terms of proximity to the lower cost production centers in Egypt and Jordan, and to Israel with its dynamic and modern industrial base. The study concludes that under these circumstances, the industries that are most promising for the West Bank and Gaza are threefold: light manufacturing industries that could exploit the ties with Israel, such as higher-end apparel manufacturing, finished consumer electronics, and electrical appliances; professional services in the information technology sector; and location-based services related to future cargo operations at Rafah airport.

1This box is almost exclusively based on The Services Group (1999 and 2000) studies financed by the USAID.

Cost-Saving Security and Customs Procedures at the Gaza Industrial Estate

The PA and the Israeli government have jointly developed cost-saving customs and security procedures exclusively applicable for the Gaza Industrial Estate (GIE). These procedures have been accompanied by measures by the PA to ease other constraints to private sector investment in the Palestinian economy. Many of the security procedures applied at the GIE could be duplicated in the rest of the West Bank and Gaza.

The GIE was created to provide a better investment environment and competitive incentive framework for promotion of exports (see Box 3.5 for the general characteristics of the GIE and comparative benchmarking with some competing export processing zones). Indeed, in relation to the rest of the economy, the GIE offers more efficient security and customs checks, advanced physical infrastructure, lower key utility prices, streamlined bureaucratic procedures through one-stop shopping for investors, and longer periods of tax reductions than those granted under the Investment Encouragement Law.

The simplification of the customs and security procedures for goods destined for exports (introduced in the summer of 2000), consists of allowing the inspection of outgoing goods to take place directly at the factory in the GIE by customs and security before loading them into containers in the presence of Israeli security. These containers are then sealed and transported without further inspection on an Israeli truck for direct delivery to the ports for export or to the final destination in Israel. Security costs are cut not only because of quicker transport but also because the damage caused to the cargo by the loading/off-loading operations is avoided. In addition, the security fee at Karni for the GIE is being phased out. The shortcoming of this procedure is, however, that it may not always be economical to use an entire container per shipment, in which case the traditional back-to-back system still has to be applied.

The USAID has recently financed a feasibility study for the establishment of a general logistics facility (GLF) serving initially the GIE and subsequently the rest of the Palestinian economy.33 This facility would include a common warehouse and a container storage yard, and the provision of a range of other services aimed at reducing the inefficiencies and costs of cargo inspection procedures, transport costs, and logistics currently faced particularly by trade in and out of Gaza. Together with the GIE, the future services envisaged by this facility address many of the most salient obstacles for doing business in the West Bank and Gaza. There are plans to establish other industrial estates in the West Bank and Gaza with a view to attracting foreign direct investment in light manufacturing and the services sector. While GIEs can succeed in achieving this objective, their contribution to growth and employment in the West Bank and Gaza is expected to be small. The PA should, therefore, be wary of relying on these estates to attract the investment of the scale required to meet its key objective of absorbing a growing labor force into productive employment while gradually reducing unemployment. Despite the increasing popularity of this type of export processing zone (EPZ), the lessons from experience show mixed results (see Box 3.6) and suggest that they can play a positive role if they are complemented by sound macroeconomic policies and liberalization efforts.

Other Proposals to Reduce Security-Related Costs

Investment in state-of-the-art security equipment would be essential to reduce costs and time. Proposals to use this type of equipment at the GIE as well as in other locations in the West Bank and Gaza are included in USAID-financed feasibility studies for projects under consideration by the PA. Container scanners are being proposed for inspection at the GIE as well as at Allenby Bridge, Rafah, and Tulkarem. The scanning time would be from 2 to 3 minutes per vehicle to which 15 minutes would need to be added for analyzing the results. As noted above, security checks normally take no less than 3–4 hours with varying differences at the various crossing points. The cost of the scanners is approximately US$7 million each and would take three months to construct. Comparable efficiency gains would be obtained through the use of similar equipment capable of a speedy inspection of an entire truck.

Containers and truck scanner techniques would significantly reduce or eliminate the risk of merchandise damage during inspection, because it would not be necessary to unload and reload the goods and also because they would allow the use of better packing material to protect the goods from exposure to sun and heat. Furthermore, many of the security-based regulations could be abolished and there would no longer be a need for trucks to be pooled in convoys, transport goods only in one direction, or observe rigid timetables. In essence, any truck with whatever shipment would be x-rayed each time it entered Israeli territory, regardless of its size and content. The above-cited USAID projects specify that no additional fees would be charged to Palestinian transporters once these machines are in use, probably leading to a significant reduction of the current fees charged at Karni, which mostly reflect the services of the private enterprise involved in handling the goods for inspection and subsequent transfer to the authorized trucks.

Box 3.6.Experiences Under Export Processing Zones

Most emerging markets and developing countries have established some form of export platform institutions, including export processing zones (EPZs) or other special economic zones (that is, industrial estates). An EPZ is usually a fenced area for companies specializing in manufacturing exports. These companies benefit from generous and long-term tax incentives, a liberal regulatory environment with less bureaucracy, and better infrastructure than the rest of the country. It is estimated that there exist some 500 EPZs spread across 73 countries (Madani, 1999). The importance of EPZs in promoting export growth and economic development is very much an open question: EPZs exist in fast-growing as well as in slow-growing economies, and it is not clear how significant their contribution has been to export growth in fast-growing economies, for example in Southeast Asia. EPZs, or other forms of economic zones, can attract foreign direct investment (FDI) by providing an environment that is more conducive to investment and economic development than what the economy as a whole can offer, and the economy as a whole can benefit from spillovers of the transfer of technology and know-how. For such spillovers to have a significant impact on economic growth and development more generally, however, it is necessary that they be accompanied by sound macroeconomic policies, open trade policy, improved infrastructure in the economy as a whole, and an adequate legal and regulatory framework. If not, the country is unlikely to experience rapid growth no matter what incentives the EPZ can offer. Based on several new studies (for example, Radelet, 1999; and Madani, 1999), the following lessons can be drawn from international experience:

1. The performance of EPZs depends on the degree of competition companies are exposed to and the general macroeconomic and trade environment. Encouraging experiences with EPZs have been limited to countries where the industrial base already existed and where quality standards of the local economy satisfied the international investors, and even then, the EPZs have only been one part of the overall industrialization policy. Consequently, in parallel with the establishment of an EPZ, governments need to improve investment conditions and initiate economic reforms in the country as a whole (especially, sound and stable monetary and fiscal policies, and clear investment and private property laws), in order to fully benefit from backward linkages with the local industry.

2. Although EPZs often lead to an increase in export earnings, their net effect on foreign earnings is less evident, as a substantial part of profits are typically repatriated to parent companies. Investment in supporting infrastructure financed by governments also usually has a high import component. Due to their often generous tax incentives, moreover, EPZs may simply have the effect of relocating existing companies eager to evade taxes from elsewhere in the country, thus reducing tax revenue and increasing foreign borrowing by the government. Thus, when establishing an EPZ it is recommended that governments adopt moderate income tax rates, avoid expensive investments and subsidies, and opt for private sector finance and management.

3. Technology transfer, learning on the job, and training in new managerial methods occurs only in cases of extensive hiring of local labor and management at all levels. In some cases, however, where production was limited to simple assembling tasks, requiring little or no technical skills, the only benefit in terms of capacity building is work discipline. In countries where property (including intellectual property) rights are not sufficiently protected, multinational companies tend to only produce products with technologies that are in the later stage of their lifespan. Governments can actively promote technology transfer by rigorously protecting property rights.

4. When EPZs are run by the public sector, bureaucracy and red tape tend to remain high. Experience shows that EPZs are more likely to succeed (and attract FDI if they are privately owned and managed and when government services, such as customs, are streamlined and performed within the zones rather than at the port.

5. Although EPZs have succeeded in creating jobs, in most countries their overall contribution to the total labor market has remained limited. Wages in EPZs, especially for non-primary manufactured exports, are generally higher than in the rest of the economy, as experience has shown that countries with high export growth rates also have consistent increases in manufacturing wages. EPZs are often criticized for their lax labor, work safety, and health and environmental regulations, however, bearing a negative impact on the workers’ welfare and on the environment. This appears to be particularly the case in comparison with high standards in the multinational companies’ home countries, but compared with the local economy, most large multinational companies often perform better in terms of both salaries and working conditions. Notwithstanding a marked improvement in such standards, partially due to scrutiny by non-governmental pressure groups, governments still need to issue and enforce appropriate labor and environmental regulations.

A proposal, being considered by the PA, that attempts to shift most of the customs transactions away from the crossing and entry points entails the establishment of Customs Clearing Houses (Jackson, 2000). This proposal was made from the perspective of a possible Israeli-Palestinian free trade agreement under permanent status and in the expectation that the convoy system would be replaced by a modern transit system, such as the one described below. The Customs Clearing Houses would use as a prototype the logistic center concept at the GIE in that they would be situated at relatively short distances from the border inspection points and provided with superior facilities and equipment to conduct the clearance and physical examination of the goods, including the security inspection. Under this system, the functions to be discharged at the border points would be to scrutinize the documentation and cargo seals, as needed, to ensure that the cargo does not enter the market before clearance at the Customs Clearing Houses. Introduction of this system would require a reciprocal agreement of the PA with Israel, Jordan, and Egypt.

Another proposal to reduce damage, delays, and costs incurred by Palestinian cargo at crossings would be the adoption of a transit regime, which would conform with international practice and allow an undisturbed movement of goods across national and international borders. One possibility would be the adoption of the TIR (Transports lnternationaux Routiers) regime, which would require a declaration in the form of a carnet to allow TIR-certified Palestinian (sealed) vehicles to transport the goods inspected between the West Bank and Gaza and neighboring countries (Jackson, 2000).34 Its implementation would require cooperation in the areas of customs among the PA, Israel, Jordan, and Egypt and of security between the PA and Israel.

Consideration could also be given to partially shifting the burden of security to Palestinian business people engaged in trade; they could seek to ensure that their merchandise is security proof and Israeli security could be conducted only randomly. The incentive for the Palestinian enterprise would be set in a way that it would be in its own interest to play by the rules of the game. For example, any slippage could be sanctioned by denying the company any future access to the Israeli territory, which would threaten the company’s very existence. Especially entrepreneurs with large fixed investment, a solid reputation and a lucrative business would have much to lose if they misused this trust or let others take advantage of it.

Finally, travel of Palestinians to Israel, be they business people, workers, or tourists, could be facilitated through investment in hand-image reading machines, for example, like those currently used by the United States Immigration Service to facilitate the admission of returning frequent travelers. This equipment has also been recommended in the above-cited feasibility studies.

Improving the Links of the Palestinian Economy with the Rest of the World

The establishment of the Gaza seaport and cargo operations at Gaza airport will greatly improve access to world markets from the West Bank and Gaza. In order for the Palestinian economy to fully benefit from the Gaza seaport and airport, it is necessary that a permanent and cost-effective passage for trade and travel be established between Gaza and the West Bank. It will also be important to invest in road rehabilitation.35 Sizable investments will be required to ensure that transportation through these ports is logistically reliable and efficient, including of passengers. To this end, it is crucial that a different security system be adopted, entailing more efficiency and significantly lower costs. These systems need to be supported by the development of an up-to-date customs declaration process.

Developing a Customs Administration and Improving Trade and Overland Transport

To further increase efficiency in trade procedures, it will be important for the PA Customs Department to strengthen its technical and administrative capacity to monitor trade compliance with the provisions of the trade system. Under the current trade arrangement, this is mostly done by Israel and the development of the PA’s capacity in the area of import/export processing is limited. The technology adopted by customs for import/export processing should allow it to target high-risk consignments for intensive check, while allowing most of the goods to flow uninterrupted. This could contribute to limiting the transaction costs expected to arise from the introduction of customs borders under a new Israeli-Palestinian free trade agreement (see Chapters 4 and 5). Adoption of this technology should be supported by a high level of integrity at Customs and other branches of the administration involved in the trade process to enforce tax compliance in conformity with the provisions of the trade arrangement. To minimize the risk of corrupt practices, the trade process and system should be transparent, predictable, and simple, entailing reduced red tape for obtaining the documentation required (export authorizations and standard certificates, for example) to conduct trade. The PA Customs could also adopt pre-shipment inspections, pending a strengthening in its administrative capacity to monitor the declared value of imports. Although the fees charged by specialized companies for these services are high, many governments use them to improve tax compliance, usually as a temporary measure pending an improvement in their customs administration capacity. In some countries, importers have opted for assisting the government to pay for the pre-inspection fees, in view of the net efficiency gains derived.

From the perspective of trade with neighboring countries, private sector representatives and UNCTAD (1999) see a role for the PA in seeking a coordinated approach in the area of customs, with a view to facilitating and enhancing trade through reduced inefficiencies and costs. This would include harmonization of customs formalities, streamlined regulations and procedures concerning trade documentation (issuance of certificates of origin, validity of import permits), establishment of customs clearing centers at the crossings, agreements on methods of processing the declaration files, and close coordination and cooperation among the customs offices. It will be critical to establish an information department in the customs office of each of the countries concerned to respond to inquiries about the trade regulations with neighboring countries. Finally, it will be necessary to make the crossing points more efficient by investing in infrastructure and logistic facilities at or near the crossings (laboratories, warehouses, restaurants, banks, post offices, insurance companies, parking, and resting places).

Closely linked to the need to improve customs formalities at the crossing points, is the question of increasing efficiency in overland transportation for trade with neighboring countries. The harmonization of legal and regulatory frameworks consistent with regional and international principles and practices of transportation could ease unnecessary barriers to the movement of goods. An example of cooperation in this regard is the above-cited agreement reached between the PA, Jordan, and Israel over the special trucks for the transport of citrus. Agreements on transportation (and customs inspection) procedures could allow door-to-door delivery of goods and replace the back-to-back transport system. In the case of imports by the PA from Jordan, for example, door-to-door delivery could translate into cheaper imports because of less costly truck services in Jordan and could lower the risk of merchandise damage. The limit on the cargo that trucks are allowed to transport is another area where harmonization would be important. In the case of stones, for example, the cargo limit prevailing in Jordan meets only part of some stone exporters’ cargo requirements, with adverse impact on their costs. Finally, governments could sign protocols permitting private transporters to take a more active role in enhancing trade logistics between countries and establishing joint businesses, and coordinating transport activities.

Information-Related Costs and the Role of the Private Sector in Trade Promotion

The Palestinian industrial sector is characterized by small, often family owned or operated businesses, for which obtaining information about export and import markets is very difficult. It also makes it very difficult and costly to keep track of continuously changing regulations that govern trade in the West Bank and Gaza.

The PA is expected to contribute to reducing these costs by, for example, assigning a team of trade experts to facilitate information to the business community in the West Bank and Gaza and contribute to their education about foreign market customers and procedures. Embassies and trade offices overseas could also contribute to trade promotion efforts. These efforts will need, however, to be supplemented by the provision of substantially expanded services by the private organizations, such as the Chambers of Commerce and Trade Associations, in line with the more active and efficient role played by their counterparts in other countries.

Concluding Remarks

The Palestinian economy presents a uniquely difficult trade environment, characterized by a very high level of transaction costs that inhibit investment and trade expansion. An important factor explaining these high costs, over and above those that are characteristic in developing countries, is the security-related regulations that adversely affect trade with the rest of the world and even within the West Bank and Gaza. Chapter 2 highlighted the need for high and sustained growth over the medium term in order to cope with demographic developments. Given the small size of the economy, trade will have to be a driving force behind such economic growth, and to this end, it is crucial that the high transaction costs be reduced.

There are immediate measures that the PA and Israel can take to reduce transaction costs, irrespective of the future trade arrangement between the two entities. These include the elimination or reduction of various fees and charges related to trade and security checks. It also includes, later on, the adoption of state-of-the-art technology that has been proposed with donor assistance to expedite inspection at the crossing points. Such measures would, however, not be sufficient to encourage a strong and sustained growth in exports. Over the longer term, transaction costs have to be reduced in four areas. First, for better allocation of resources and more efficient production, the Palestinian economy needs direct access to the rest of the world by air and sea. Second, the Gaza Strip and the West Bank must be connected through a passage that will enable the free movement of goods and people. This reform needs to be supported by investment in physical infrastructure (for example, better roads). Third, the efficiency of the trade infrastructure needs to be raised through the adoption of streamlined customs procedures and modern logistical handling of goods, to ensure that the Gaza seaport (once finished) and airport actually reduce transaction costs. Fourth, security checks will need to become more efficient and effective, by adopting the most up-to-date technology and internationally accepted in-transit procedures to ensure speedier processing and minimum damage to goods.

From a regional perspective, there are also several routes to facilitate and expand trade. This will require a collaborative approach, like the one between the PA and Israel as regards security and customs procedures in the Gaza Industrial Estate. Similarly, an agreement between the PA, Israel, and Jordan as regards inland transport has facilitated Palestinian citrus exports to Jordan.

Undoubtedly, achievement of the above goals presents important challenges. As discussed in this chapter, however, there are realistic ways as to how these objectives can be met. A substantial reduction in transaction costs would be a pillar—together with other efforts that the PA is currently undertaking in liberalizing and developing its economy—in promoting strong export growth to improve the living standards in the West Bank and Gaza.

1The term institutions is used here in its broad sense to encompass all the “rules of the game” or the “humanly devised constraints that structure political, economic, and social interaction. They are made up of formal constraints (e.g., rules, laws, and constitutions), informal constraints (e.g., norms of behavior, conventions, self-imposed codes of conduct), and their enforcement characteristics.” (North, 1994, p. 85). See Furubotn and Richter (2000) for a recent overview on theoretical developments in transaction cost economics (which is concerned with
2It is also important to note that although in aggregate such costs are quite high (comprising some 50 to 60 percent of net national product in industrialized economies), they tend to be small per transaction (North, 1987). They usually include incomes of lawyers, financial institutions, policemen, middlemen, entrepreneurs, managers, clerks and civil servants. Even the notion of transportation costs, can arguably be understood as transaction costs, as it encompasses not just the physical transportation of goods but also “costs of communications and the idea that countries tend to have a better understanding of their neighbors and institutions.” (Frankel, Stein, and Wei, 1995, p. 76). Most analyses, however, consider transaction costs as separate from transportation costs.
3As more individuals and companies leave the formal sector, tax revenues tend to fall, thus creating a vicious cycle of low provision of public services, poor quality of infrastucture, and less willingness on the part of the public to pay for them.
5Business people have to deal with separate government offices in the West Bank and Gaza and often with both the Palestinian and Israeli bureaucracies.
6It can be argued that technical progress is by far the most important factor influencing transaction costs. Whereas all other factors normally yield once-and-for-all effects, technical progress continually reshapes the interplay between transaction costs and production costs by inducing firms to concentrate on a narrower range of products (Tavares de Araujo, 1998). Moreover, technical progress in the specific area of improving customs handling of traded goods or transport procedures has a direct influence on reducing the level of trade-related transaction costs.
7The external trade process is handled by two layers of bureaucracy (the PA and Israel) and. with few exceptions, the Israeli trade system applies to Palestinian trade by virtue of the customs union with Israel. The prevailing trade system is explained in Chapter 4 (see also Calika, 1998; Kessler, 1999; and Box 3.2).
8See, for example, Brunetti and others (1997) and a recent World Rank business environment survey (see Sewell, 2001).
9This study of transaction costs lacing Palestinian businesses—Federation of Palestinian Chambers of Commerce, Industry, and Agriculture (FPCCIA) (1998)—is based on interviews with key decision makers and trade experts from both the private and public sector, including about 30 Palestinian and Israeli company managers, 20 government officials from both the PA and Israel, and many port authority officials, clearing agents, and representatives of non-governmental organizations.
10The discussion in this section is based on a review of trade-related regulations and procedures conducted by an IMF team, as they prevailed at the time of its visit in August 2000. In conducting this task, the team was provided with extensive information by the Palestinian Ministry of Trade and Economy, by private sector representatives, and by UNCTAD (1999), The Services Group (1999), the FPCCIA (1998), and Kessler (1999).
11Under the Interim Agreement, the West Bank (excluding Jerusalem) is divided into three categories of civilian control (A, B, and C), with varying degrees of responsibility between the PA and the Israeli government. The PA is responsible for civilian affairs in the three areas to various degrees; the responsibility for maintaining security is in the hands of the PA in area A, of the Israeli government in area C, and jointly in area B.
12The total road network in the West Bank and Gaza is about 4,900 km long (approximately 3,000 miles), of which 2,500 km are roads connecting major cities and crossing points. According to the Interim Agreement, the PA is fully responsible for the roads in area A. which encompasses the major cities. Construction or rehabilitation of roads passing through areas B and C need prior approval from the Israeli authorities (UNCTAD, 1999).
13Since March 2000, however, a significant part of trade conducted through Erez has been diverted to Karni and the intention is to limit. Erez to the crossing of people, and limit goods transport to cement imported from Israel. As of September 2000, however, the measure had not yet been fully implemented, and Gazan flowers and strawberries intended for exports were still being transported through Erez while industrial products, Other agricultural products, and garments were routed through Karni.
14The interdiction to travel through Jerusalem forces deviation through bypass roads and consequently a longer journey.
15Magnetic ID cards are a prerequisite for obtaining a vehicle permit.
16All petroleum products and the bulk of cement are imported from Israel.
17Trade flows between the West Bank and Israel’s ports and airport mostly use Israeli licensed trucks, which are allowed to proceed all the way to their final destination. These goods are only selectively inspected by Israeli security, and the security checks are less of an obstacle than at Gaza. Sterilized trucks at Erez are used to transport Gazan goods to the West Bank.
18For trade destined to Gaza, the reverse procedure is followed.
19A convoy of green trucks normally consists of 15 trucks.
20Besides the security inspections performed at the crossing points, there are five checkpoints where Palestinian goods going to the West Bank and Gaza may be subject to controls. These checkpoints are along the green line between the West Rank from Israel: Ramallah, Jenin, Tulkarem, Al-Fawwar, Jerusalem, and Hebron (Kessler, 1999).
21As convoys can only be organized for a specific date, late arrival of the shipment will result in the return of the truck to Gaza and duplication of the transport arrangement. For this reason, the Palestinian Export/Import Guide (PA Ministry of Economy and Trade, 1999) recommends that importers calculate carefully both the arrival date of the shipment and the duration of the clearing process. The number of trucks allowed to constitute a convoy varies from 10 to 40. According to UNCTAD (1999), convoys carrying Gaza products destined for export to or through Jordan usually travel one of two different routes (see Map 1).
22Damya is used mainly for refrigerated cargo, flowers, and vegetables due to limited facilities. Some Palestinian business people have access to permits for their cars, which are given the status as sterilized trucks. As such, the cars must be parked at the security zone at Erez; the cost of the permit is NIS 300.
23Goods from Israel are not inspected at Karni, they only undergo a back-to-back procedure.
24The same schedule applies at Allenby and Rafah crossings.
25The fee applies to big trucks; small trucks are charged NIS 270.
26This cost differential, in addition to the stricter security procedures in relation to Erez, has led to complaints by Palestinian traders and trucking companies over the planned rerouting of trade through Karni. The facilities at Karni are being expanded for automated trade, while those at Erez are not.
27West Bank exports through these points are either loaded on green or other Palestinian licensed trucks and follow the security procedures explained above.
28In principle, 51 trucks from Jordan are allowed in per day at Allenby. Since trucks are allowed in one at a time, however, the limit is never reached in practice on any given day. However, the composition of trucks allowed daily for exports may change in favor of a larger share of trucks carrying agricultural goods at the height of the agricultural season.
29In particular, exports of fresh or perishable products are impractical owing to the risk of damage during the inspection procedures. As in Allenby, the number of trucks allowed to cross Rafah daily is relatively small (13–15) in relation to the number of authorized in principle (about 50).
30These delays have often induced importers to stockpile goods at the factory, and on the export side, they have compromised the credibility of the exporter and resulted in contract cancellations. For stones, for example, waiting time by trucks at Allenby of 4–5 hours is not unusual.
31Information provided by private sector representatives. According to them, cost effectiveness is also affected by the requirement that trucks carrying Palestinian goods return empty from the bridges.
32The charges vary depending on whether the goods occupy all or part of a container. If an entire container is used, the importer has six days free of storage and demurrage (payments for delays in returning the containers). If there are delays, however, storage is paid starting from the day of arrival of the goods while demurrage is paid starting on the seventh day. If shipments are smaller than a container, one-month free of demurrage and storage charges are allowed. On average, the charges are US$25 per day for a 20-foot container.
33See The Services Group (2000). If established, the GLF would allow the payment deferral of import duties on high value import containers and truck loads until clearance, and storage for low value cargoes. Another service would consist of the provision of locations for the storage and consolidation of export cargo and deconsolidation of import cargo, and of office space for shipping companies and forwarders serving the factories in the GIF. The project envisages that once cargo inspection procedures become more efficient, and transport, cargo clearance, and other logistics services are open to competition, the GLF would evolve into a dry port, where shipping lines could issue bills of lading and receive or deliver cargo. With the construction of the Gaza seaport, the role of the installations would change into a more general container freight station supplementing the limited storage capacity at the seaport. The targeted market would initially be cargo transfer in bond between Gaza and either Ashdod or Ben Gurion. Future plans would include extending these services to cargo transferred through the Gaza seaport for the Palestinian economy, and to transit cargo via Gaza through Jordan or Egypt to the Gulf countries.
34The TIR Convention of l975, drawn under the auspices of the United Nations, is also known as the International Transit System.
35Most of the main roads that access crossing points are considered to be in fair condition. Overall, however, 50 percent of the roads have been classified by the Ministry of Public Works as being in poor condition. The PA’s current budget allocations for road maintenance amount to US$3 million per year, which is less than one-third of the amount required for annual routine and periodic maintenance (UNCTAD, 1999).

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